Freeport McMoRan: Investing In Fool's Gold

While the global monetary printing presses are running 24/7, gaining exposure to nonrenewable resources has been a popular and logical way to protect portfolios against the threat of inflation. As such, Freeport McMoRan (NYSE:FCX) was considered a "pure-play" on commodities because, as stated on their 10-Q, the firm doesn't normally intervene in the capital markets to hedge against the price of the precious metals it curates.

"On limited past occasions, in response to market conditions, we have entered into copper and gold price protection contracts for a portion of our expected future mine production to mitigate the risk of adverse price fluctuations. We do not currently intend to enter into similar hedging programs in the future."

As evidenced by the chart below, there's been nice money to be made over the last few years by establishing a long position in the $30-$32 range and holding for a few months time. So naturally, my trading ears perked up after the market punished the stock following the announcement of the (NYSE:PXP) and (NYSE:MMR) acquisitions, sending shares back down to my previous "buy" levels.

(click to enlarge)

I was almost willing to look past the seemingly illogical acquisition of two oil and natural gas companies by the precious metals firm because the pre-acquisition FCX stood out relative to its peer group in terms of profitability and valuation. The following snapshot demonstrates an attractive, non-merged, FCX using its current price and performance data as of year- end 2012:

Profitability

FCX

FCX Peers

Industry Average

Operating Margin (TTM)

31.35%

8.65%

16.64%

Net Profit Margin

22.08%

11.42%

1.86%

Valuation

FCX

FCX Peers

Industry Average

P/E Normalized

9.8

9.9

10.6

P/Sales

1.7

2.3

0.8

P/Tangible Book

1.7

2.4

3.3

P/Cash Flow

5.9

15.1

12

Financial Strength

FCX

FCX Peers

Industry Average

Current Ratio

3.1

2

3.4

Total Debt/Equity

0.2

0.5

0.5

Management Effectiveness

FCX

FCX Peers

Industry Average

Return on Assets

11.78%

6.12%

2.47%

Return on Equity

18.33%

9.27%

3.16%

Return on Investments

14.58%

7.61%

8.65%

However, after investigating the recent acquisitions of PXP and MMR, I refused to pull the trigger due to the blatantly-tragic lack of corporate governance exploited by Freeport's Chairman of the Board James Moffett.

James "Jim Bob" Moffett is both the Chairman of the Board for Freeport McMoRan and CEO of the recent acquisition target McMoRan Oil and Gas . According to a Bloomberg article published days before the acquisition announcement, MMR was in serious trouble. Over four years, MMR had spent $991 million on the "Davy Jones" natural gas well in the Gulf of Mexico to only produce inconclusive results. Back in November, the disheartening news about Jim Bob's gamble on Davy Jones sent shares down 34% to $8.18 and left Wall Street super bearish on the company. Following the announcement, analyst at JP Morgan updated their price target to $2.31, a 72% discount to shares at the time and analysts at RBC noted MMR had "really put their eggs in one basket" and an unsuccessful Davy Jones project "really makes it difficult for the company going forward." Furthermore, a WSJ article cited expectations of the firm running out of cash by mid 2013. The MMR punishment surely put a temporary damper on ole Jim Bob's pocketbook and a snapshot of the MMR's performance metrics highlights a firm in dire need of a miracle:

Profitability

MMR

MMR Peers

Industry Average

Operating Margin

-25.90%

22.53%

28.32%

Net Profit Margin

-25.75%

13.71%

7.18%

Valuation

MMR

MMR Peers

Industry Average

P/E Normalized

-

47.2

46.5

P/Sales

6.9

5

3.1

P/Tangible Book

1.6

3.4

5.8

P/Cash Flow

-

11.9

6.3

Management Effectiveness

MMR

MMR Peers

Industry Average

Return on Assets

-3.46%

3.55%

4.92%

Return on Equity

-10.59%

8.63%

4.94%

Return on Investment

-4.01%

3.95%

52.53%

Financial Strength

MMR

MMR Peers

Industry

Current Ratio

0.6

1.3

1.1

Total Debt/Equity

0.3

0.6

0.7

As an investor, I wouldn't touch MMR with a ten-foot pole however, Freeport McMoRan conveniently made an offer $14.75 a share, a 74% premium over the closing price on December 4, 2012. According to Reuters, Moffett collected $73 million for his shares in the and . It's always good to have friends in high places and in Moffett's case; it's good to be ole' Jim Bob.

To be fair, from a relative value perspective, as a firm looks like a more reasonable investment although still highly questionable as a strategic acquisition for a mining company:

Profitability

PXP

PXP Peers

Industry Average

Operating Margin

23.70%

20.54%

28.32%

Net Profit Margin

13.36%

11.23%

7.18%

Valuation

PXP

PXP Peers

Industry Average

P/E Normalized

17.7

19.8

46.5

P/Sales

2.3

2.3

3.1

P/Tangible Book

2

2.8

5.8

P/Cash Flow

4.1

6.5

6.3

Management Effectiveness

PXP

PXP Peers

Industry Average

Return on Assets

2.53

3.97

4.92

Return on Equity

9.04

8.57

4.94

Return on Investments

2.79

4.61

52.53

Financial Strength

PXP

PXP Peers

Industry Average

Current Ratio

1.9

1.3

1.1

Total Debt/Equity

2.8

0.6

0.7

Investors would be much better off diversifying their own portfolio with better energy stocks and even if one wanted to own PXP and MMR, they would be better served not paying the 39% and 74% acquisition premium to do so.

Even though I doubt ole' Jim Bob will be ousting himself as Freeport's Chairman of the Board anytime soon, I still believe it's prudent to uncover a fair value estimate of the post-acquisition Freeport McMoRan. I accounted for the lack of synergies by combining the three company's financial performance as of 12/31/2012 and assumed the companies operate independent of each other. Below is the combined result of the three company's net income, deprecation, capital expenditures, and working-capital per share in a free cash flow to equity model using the post-acquisition amount of 1,041 million shares outstanding. For the cost of equity I used a combined beta of 1.79, which represents the beta of each firm weighted by their market cap as of the close Friday, March 1, 2013. Additionally, the desired debt ratio of 33% represents the Total Debt/ Market Capitalization of the 3 combined companies:

This is the output from the Gordon Growth Model

Firm Details: from inputs on prior page

Current Earnings per share =

$3.11

-(1- Desired debt fraction) *

67.00%

(Capital Spending - Depreciation)

$2.89

$1.93

-(1- Desired debt fraction) *

67.00%

∂ Working Capital

($1.56)

($1.05)

Free Cashflow to Equity =

$2.22

Cost of Equity =

11.71%

11.713

Expected Growth rate =

4.00%

Gordon Growth Model Value

$29.95

Given the sensitivities to inputs in the model, I've included the intrinsic value per share based on several different growth rates and also included the FY earnings for all 3 companies over the latest five year period as a benchmark for expected future growth rates:

Growth rate

Value

FCX

eps

PXP

eps

MMR

eps

8.00%

$64.61

12/31/12

3.19

12/31/12

2.32

12/31/12

-0.86

7.00%

$50.43

12/31/11

4.77

12/31/11

1.44

12/31/11

-0.31

6.00%

$41.22

12/31/10

4.57

12/31/10

0.73

12/31/10

-2.04

5.00%

$34.75

12/31/09

2.93

12/31/09

1.09

12/31/09

-2.79

4.00%

$29.95

12/31/08

-14.86

12/31/08

-6.52

12/31/08

-3.79

3.00%

$26.26

2.00%

$23.33

1.00%

$20.94

Conclusion:

At its current share price, Freeport McMoRan has historically been a worthy trade given its exposure to precious metals, sound fundamentals, and strong technical support. But after the most recent acquisitions, I believe management hubris has reared its ugly head at the expense of shareholders and thus I recommend avoiding this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

We only use your contact details to reply to your request for more information.We do not sell the personal contact data you submit to anyone else.

Thank you for your interest in Seeking Alpha PROWe look forward to contacting you shortly for a conversation.

Thank you for your interest in Seeking Alpha PRO

Our PRO subscription service was created for fund managers, and the cost of the product is
prohibitive for most individual investors.
PRO Alerts is our flagship product for individual investors who want to be faster
and smarter about their stocks. To learn more about it, click here.
If you are an investment professional with over $1M AUM and received this message
in error, click here and you will be contacted shortly.

Thank you for your interest in Seeking Alpha PROWe look forward to contacting you when we have an individual investor product ready!